Capital improvements and separate assets

If you acquired a dwelling before 20 September 1985 (when CGT came into effect) and make major capital improvements after that date, part of any capital gain you make when a CGT event happens to the dwelling could be taxable.

Even though you acquired the dwelling before CGT started, major capital improvements are considered to be separate CGT assets from the original asset and may therefore be subject to CGT in their own right.

If the dwelling is your main residence and you use the improvements as part of your home, they are still exempt. This includes improvements on land adjacent to the dwelling (for example, installing a swimming pool) if the total land, including the land on which the dwelling stands, is two hectares or less.

However, if the dwelling is not your main residence or you use the improvements to produce income for any period, the part of any gain that is attributable to the improvements for that period is taxable.

In addition, there are other circumstances where a building or structure is considered to be a CGT asset separate from land – for example, if the land is acquired before 20 September 1985 and the building is constructed on or after that date.

What is a major capital improvement?

If you make a capital improvement to an asset you acquired before 20 September 1985 (such as renovating a house), it's considered a 'major capital improvement' if its original cost (indexed for inflation if the improvements were made under a contract entered into before 11:59am on 21 September 1999) is:

more than 5% of the amount you receive when you dispose of the asset

more than the improvement threshold for the income year in which you dispose of the asset.

In this case, the improvement is treated as a separate asset that is subject to CGT, unless the main residence exemption applies.

Improvement thresholds

The improvement threshold takes inflation into account.

Income year

Threshold

1985–86

$50,000

1986–87

$53,950

1987–88

$58,859

1988–89

$63,450

1989–90

$68,018

1990–91

$73,459

1991–92

$78,160

1992–93

$80,036

1993–94

$80,756

1994–95

$82,290

1995–96

$84,347

1996–97

$88,227

1997–98

$89,992

1998–99

$89,992

1999–2000

$91,072

2000–01

$92,802

2001–02

$97,721

2002–03

$101,239

2003–04

$104,377

2004–05

$106,882

2005–06

$109,447

2006–07

$112,512

2007–08

$116,337

2008–09

$119,594

2009–10

$124,258

2010–11

$126,619

2011–12

$130,418

2012–13

$134,200

2013–14

$136,884

2014–15

$140,443

2015–16

$143,392

2016–17

$145,401

2017-18

$147,582

Calculating your capital gain or loss on major improvements

When you dispose of the dwelling, you calculate the capital gain or loss on the major improvements by taking away the cost base of the improvements from the proceeds of the sale that are reasonably attributable to the improvements.

A − B = C

Where:

A is the proceeds of sale attributable to improvements

B is the cost base of improvements

C is the capital gain on major improvements

In calculating the amount of capital proceeds to be attributed to the improvements, you must take whatever steps are appropriate to work out their value. If you make an estimate of this amount, it must be reasonable and you must be able to show how you arrived at the estimated amount.

The method you can use for the calculation depends on the date you entered into the contract for the improvements.

Example: Improvements to a dwelling acquired before 20 September 1985

Martin bought a home in 1984. On 1 December 1993, he undertook major renovations to his home, costing $150,000. He sold the home for $500,000 under a contract that settled on 1 December 2017. At the date of sale, the indexed cost base of the improvements was $168,450.

Of the $500,000 he received for the home, $200,000 could be attributed to the improvements. Martin used the improvements to produce income from the time they were finished until the time he sold them with the home.

The 'home first used to produce income' does not apply because the improvements were first used to produce income before 21 August 1996.

Test 1

Is the cost base of the improvements more than 5% of $500,000 (that is, $25,000)? Answer: Yes

Test 2

Is the cost base of the improvements more than the 2017–18 threshold of $145,582? Answer: Yes Because the improvements were made under a contract entered into before 11.45am on 21 September 1999, the indexed cost base is used for the purpose of these tests.

As the answer to both questions is 'yes' and the improvements were used to produce income, the capital gain on the improvements is assessable.

As Martin acquired the improvements before 21 September 1999 and sold the home after that time, and had held the improvements for at least 12 months, he could use either the indexation method or the discount method to calculate his capital gain on the improvements.

Indexation method

Martin calculates his capital gain using the indexation method as follows:

Amount of proceeds attributable to the improvements

$200,000

less cost base of improvements indexed for inflation

$168,450

Taxable capital gain

$31,550

Discount method

Martin's capital gain using the discount method (assuming he has no other capital losses or capital gains in the 2017–18 income year and does not have any unapplied net capital losses from earlier years) is:

Amount of proceeds attributable to the improvements

$200,000

less cost base of improvements (without indexation)

$150,000

Capital gain

$50,000

less 50% discount

$25,000

Net capital gain

$25,000

Therefore, Martin would choose the discount method because this gives him a lower capital gain.

If the improvements had been used as part of Martin's main residence, this gain would be exempt. However, if the home (including the improvements) had been rented out for one-third of the period, one-third of the capital gain made on the improvements would have been taxable.

If construction of the improvements started after 13 May 1997 and they were used to produce income, Martin would also reduce the cost base by the amount of any capital works deductions he claimed or can claim. If Martin makes a capital loss, the reduced cost base of the improvements is reduced by the amount of any capital works deductions, irrespective of when construction started.

End of example

Separate assets for CGT purposes

The common law principle is that anything attached to land becomes part of the land. Therefore, a building affixed to land will be considered a single asset at common law. There are exceptions to the common law principle for CGT purposes.

Exceptions for CGT purposes

In some circumstances, a building or structure is considered to be a CGT asset separate from the land.

Major capital improvements to an asset (including land) acquired before 20 September 1985 may also be treated as a separate CGT asset.

Assets subject to a balancing adjustment

A building, structure or other capital improvement on land that you acquired on or after 20 September 1985 is a separate CGT asset, not part of the land, if a balancing adjustment provision applies to it. For example, a timber mill building is subject to a balancing adjustment if it is sold or destroyed, so it is treated as a separate asset from the land it is on.

Buildings and structures on land acquired before 20 September 1985

A building or structure on land that you acquired before 20 September 1985 is a separate asset if:

you entered into a contract for the construction of the building or structure on or after that date, or

there is no contract for its construction and construction began on or after that date.

Buildings and structures on land treated as a single asset

Excluding where the exceptions above apply, land acquired before 20 September 1985 which had a building on it will be treated as a single asset.

If that building is subsequently removed from that land and placed on new land which was acquired after 20 September 1985, it will be treated as part of the land asset acquired after 20 September 1985. The relocation of the building will result in it becoming part of a combined, single 'post-CGT asset'. The cost base and reduced cost base of the building would be added to the cost base and reduced cost base of the new land to which it is affixed.

Depreciating asset that is part of a building

A depreciating asset that is part of a building or structure is taken to be a separate CGT asset from the building or structure.

Adjacent land

If you acquire land on or after 20 September 1985 that is adjacent to land that you already owned as at 20 September 1985, it is taken to be a separate CGT asset from the original land, even if you amalgamate the two titles.

Example

On 1 April 1984 Dani bought a block of land. On 1 June 2018 she bought an adjacent block. Dani amalgamated the titles to the two blocks into one title.

The second block is treated as a separate CGT asset acquired on or after 20 September 1985 and is, therefore, subject to CGT.

If you acquire land or a dwelling before 20 September 1985, and make major capital improvements or build on the land after that date, part of any capital gain you make when a CGT event happens could be taxable.

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